Why a Greek Default Would be Worse Than Lehman Brothers' Collapse

Very interesting article however even if they do default it wouldnt matter, markets would fall a whole 8% in a few days then rally back to new highs as if there was no such thing as Greece defaulting, so if it does happen and markets turn south just buy because they will prop everything right back up. Maybe that will be the excuse for QE3, right Bubble ben bernanke!!

If Greece defaults on its debt, the direct secondary effects on financial institutions could be much worse than what we saw after the collapse of Lehman Brothers.

The collapse of Lehman Brothers sent shockwaves through the global financial systemâin part because it revealed that the United States government was willing to let a large, interconnected, complex financial company go bankrupt. Panic erupted, threatening the financial stability of other companies.

But the actual direct effects were few. Lehman had some 600,000 derivatives contracts and hundreds of billions in outstanding bonds, but Lehmanâs institutional creditors were generally required to reserve some capital against Lehmanâs collapse. This greatly diminished the direct knock-on effects of Lehmanâs bankruptcy. Capital cushions actually cushioned.

There is roughly 270 billion Euros in outstanding Greek sovereign debt. Banksâmostly European banksâhold around 100 billion Euros of Greek bonds. Insurance companies, pensions funds and central banks hold most of the other 170 billion. For the most part, these holders of Greek debt have not had to reserve any capital against losses. This means that most of the holders of Greek debt will feel the full brunt of the losses, which raises the question of whether they are adequately capitalized to take the loss.

European bank capital regulations treat Eurozone sovereign debt as riskless. This was, in effect, a subsidy to the riskier Eurozone governmentsâallowing them to borrow at far lower costs than they other would have faced. The spread between German and Greek debt fell to 20 basis points in 2004, thanks largely to this subsidy.

Banks, of course, loaded up on the riskier debt because it had slightly higher yields. They, in effect, adopted the view of regulators that the debt was risk free. It allowed them to earn higher yields without setting aside additional capital by lending money to borrowers whom the regulations disfavored.

This subsidy was extremely important to European governments. In the US, only 3 percent of government debt is held by banks. In Europe, 30 percent of government debt is held by banks. Without the subsidy, many Eurozone government would have had a much harder time selling their bonds.

(Incidentally, a similar regulatory delusion about risk applied to mortgages. Banks that held highly rated mortgage-backed securities had to set aside just half the capital they did for most other highly rated loans. So, of course, bank balance sheets were far overexposed to mortgages).

This high concentration of sovereign debt in European banks raises the possibility that the banks may be severely undercapitalizedâand may require a government recapitalization or face failure themselves. Even the European Central Bank, which now holds a huge amount of Greek debt, may need to be recapitalized.

It is difficult to tell which European banks have the most exposure to a possible Greek default. And this could be a recipe for panic if a default occurs. Banks will know their own exposures but not the exposures of their counterparties. Fearing the worst, many may simply refuse to extend credit to potentially insolvent institutions. A great credit crunch could further imperil Europeâs financial institutions and economies.

But make no mistake. This is not a crisis caused by speculators or greed or capitalism. It is a crisis of governments and regulations, i.e. governments that borrowed too much and regulators that encouraged banks to lend those governments too much.

Greece is just another symptomatic part of the global banking system that gorges on credit and then at the end of the meal gets bailed out in a spectacular fashion for 100 cents on the dollar. Somehow this is all supposed to strike fear in our eyes like this is a real event that has massive consequences...

All Lehman ever did was facilitate a major bailout. Banks in Europe will need plenty of these bailouts probably for the next 10 years. Get used to it.

Some of it, but I think people overestimate Greece's importance in the scheme of things, and the entire PIIGS group for that matter. If we were so inclined, central Europe+Scandinavia could buy the PIIGS a few times over and the impact would be unpleasant but certainly nothing shocking. Of course there is no reason to do that and if they cannot manage with the help they are already getting some will probably fail. This is still not bad and a long term positive for the euro and economic growth, as I doubt it would have much effect on central growth and peripheral growth could pick up significantly after such an event.

Having said that, Greece could still become a second Lehman for the same reason Lehman "caused" (implicitly) the financial crisis without really being a very major event itself. Like Lehman, a Greek default might be too much for the derivatives markets (and their participants) to handle. Just like AIG, I wouldn't be surprised if there were systemic parties who were short unsustainable chunks of Greek CDS which could shred the newly rebuilding financial confidence in a heartbeat, and I doubt the government will step in this time.

Some of it, but I think people overestimate Greece's importance in the scheme of things, and the entire PIIGS group for that matter. If we were so inclined, central Europe+Scandinavia could buy the PIIGS a few times over and the impact would be unpleasant but certainly nothing shocking. Of course there is no reason to do that and if they cannot manage with the help they are already getting some will probably fail. This is still not bad and a long term positive for the euro and economic growth, as I doubt it would have much effect on central growth and peripheral growth could pick up significantly after such an event.

Having said that, Greece could still become a second Lehman for the same reason Lehman "caused" (implicitly) the financial crisis without really being a very major event itself. Like Lehman, a Greek default might be too much for the derivatives markets (and their participants) to handle. Just like AIG, I wouldn't be surprised if there were systemic parties who were short unsustainable chunks of Greek CDS which could shred the newly rebuilding financial confidence in a heartbeat, and I doubt the government will step in this time.

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spain is 20% of the EU, i doubt once you add the rest of the pigs in that europe could buy them all several times over, that's like saying the totality of the us debt both admitted and unrealized is just a pittance we could pay off quickly without pain if we so chose

and the real problem is that these countries are just a domino, if one goes- then the banks who hold that debt in another country take a huge capital hit and have to be recapitalized, then whatever country foots the bill will get hit and whichever banks own their debt will need to be recapitalized- the ECB can't afford to continue to recapitalize them and germany won't foot the bill forever for the peripheries foolishness.

there isn't enough money in the world to throw at the debt problems we have all built up.

spain is 20% of the EU, i doubt once you add the rest of the pigs in that europe could buy them all several times over, that's like saying the totality of the us debt both admitted and unrealized is just a pittance we could pay off quickly without pain if we so chose

and the real problem is that these countries are just a domino, if one goes- then the banks who hold that debt in another country take a huge capital hit and have to be recapitalized, then whatever country foots the bill will get hit and whichever banks own their debt will need to be recapitalized- the ECB can't afford to continue to recapitalize them and germany won't foot the bill forever for the peripheries foolishness.

there isn't enough money in the world to throw at the debt problems we have all built up.

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Well at least you know you're dumb, that's something.

You are also incorrect, Spain is a little under 10% and all the PIIGS combined (I added Belgium for good measure too, although it's not even really a country) are about 28% of the European Union. Out of those only Italy and Spain really carry any weight.

Even if they all leave the Eurozone, who cares? This contagion bullshit is utter nonsense and I'm beginning to get annoyed at this constant "crisis mode" that we seem to be operating in recently. There are NO problems in Germany, France, the Netherlands and Scandinavia and these countries will continue to have no problems and possibly benefit from kicking out the irresponsible and lazy freeloaders. It's always something and it never really matters that much. A lot of European stock indexes aren't even above the April 2010 high yet.

At any rate the current situation cannot be explained as a negative for the Eurozone. There is no evidence that a Lehman-like crisis could occur since banks are capitalized enough to deal with the possible haircuts (and remember Greece is only 0.5% of Europe's GDP and PIG is less than 2%. There is NO WAY 2% could create contagion for the other 98%. Only Spain and/or Italy could cause this but it will be because they intrinsically suck and not because of P, I or G). The only real danger is that a derivatives crisis could possibly occur but the odds of that happening are nowhere near 100%.

Solvent, insolvent who gives a shit really? If all the people of the non-PIG states would keep giving a few euros a month to them (on average) there wouldn't be a problem, but I can understand there is little political will to subsidize some banana republic's lavish lifestyle.

You are also incorrect, Spain is a little under 10% and all the PIIGS combined (I added Belgium for good measure too, although it's not even really a country) are about 28% of the European Union. Out of those only Italy and Spain really carry any weight.

Even if they all leave the Eurozone, who cares? This contagion bullshit is utter nonsense and I'm beginning to get annoyed at this constant "crisis mode" that we seem to be operating in recently. There are NO problems in Germany, France, the Netherlands and Scandinavia and these countries will continue to have no problems and possibly benefit from kicking out the irresponsible and lazy freeloaders. It's always something and it never really matters that much. A lot of European stock indexes aren't even above the April 2010 high yet.

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The problem is with the banks, obviously.

Deutsche bank, ING, BNP Paribas, they all own tens if not hundreds of billions of Italian, Spanish, Belgian savings and bonds.

To think this offers no contagion effect should any of them get into trouble is kind of a stretch let's agree on that no.

Deutsche bank, ING, BNP Paribas, they all own tens if not hundreds of billions of Italian, Spanish, Belgian savings and bonds.

To think this offers no contagion effect should any of them get into trouble is kind of a stretch let's agree on that no.

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That Locotus post was one of the dumbest things I've ever read.
The German banks were already notorious for being the saps on the other side of American CDOs. They're already shaky.
Anyway, Greece won't default, they'll restructure. This is a lot less painful. It would be treated as a partial default, but it wouldn't likely cause much of a banking crisis.
Also, German bullshit aside, they've been over the ECU limit on deficits more often and for longer than Italy. This total stupidity about German "prudence" is a smelly pile 'o shit. Merkel's been engaged in trying to deflect attention away from the non-existent risk management of the German banks, and has done so, quite successfully at that, by calling the peripherals imprudent (despite the fact that Ireland and Spain had rock-solid gov't finances prior to the late unpleasantness. Ireland's big mistake was guaranteeing the bank bondholders. Why they did that is incomprehensible).
If the peripherals were imprudent, what were the banks who lent them money?
Stupid.